Three million pensioners are being urged to reclaim tax on their savings –
worth up to £1,200 – after an influential Government department recommended
that the 10pc rate be axed.

The Office of Tax Simplification has called for an urgent overhaul of the way that pensioners are taxed. While this should simplify many people's financial affairs, many could lose out on thousands of pounds of interest on their savings if the 10pc tax rate is abolished.

Evidence suggests that the vast majority of pensioners and low earners who are entitled to pay less tax on their savings do not claim this benefit.

Those who have missed out are being urged to reclaim now before the benefit disappears. As people can backdate claims for four years, this should mean some pensioners will collect a tax rebate worth almost £1,200.

Savings campaigners such as Save Our Savers have called for a change in the way the tax on savings is applied. At present those whose income exceeds the personal allowance will have 20pc deducted from the interest paid on their savings, unless it is in a tax-free Isa.

If their income (excluding any savings) is less than £13,210 (or £13,370 if you are over 75) then they can reclaim half of the tax paid. This is done by completing either a self-assessment form or a special HMRC form – known as an R40.

Typically this will give pensioners an extra £90 a year in interest, but the maximum that can be earned is £271. Those who haven't claimed this rebate and now are reclaiming for four years could be due a sizeable sum. Although interest rates are currently low, some of these savers would have had money locked into fixed-term bonds, which paid far more competitive rates three or four years ago.

Jason Riddle of Save Our Savers said: "Many pensioners and those on low incomes are not getting the tax benefit to which they are entitled. But the Government should make it easier to claim this tax, not get rid of it completely. This is a real slap in the face for low-income savers, who have already seen the interest they get on their savings collapse by 60pc since the start of the financial crisis."

He said the current system was "unfair and inequitable" as it effectively gave higher-earners paying 40pc tax generous credit terms – they don't have to pay the tax they owe on their savings until the end of the tax year, while pensioners and others on low incomes have to overpay immediately, then fill out various complex forms to get their money back.

However, the Office of Tax Simplification said that while the 10pc tax rate should be removed, the Government should raise the tax-free Isa limit to ensure that those in these income bands would not lose out.

A spokesman said: "Work would have to be done to see what an appropriate Isa limit would be, after this change." The Government may be unlikely simply to raise the Isa limit by the full amount, as this would reduce the Treasury's tax take on savings – particularly as so few people claim the 10p rate.

TIPS: HOW TO PAY LESS TAX ON YOUR SAVINGS

– If your total earnings are less than the personal allowance, you need to complete an R85 form – this ensures that all interest is paid gross, without 20pc tax being deducted at source. For those under 65 the personal allowance is currently £8,105, rising to £10,500 for those aged between 65 and 74 and £10,660 for those aged 75 and over.

– If your total earnings are more than £13,210 (or £13,370 if you are over 75) you don't qualify for the lower rate of tax on your savings, not even the first portion of your savings. Make sure you make the most of the tax-free Isa allowance. You can save up to £11,280 into a Isa, of which half (£5,640) can be saved in a cash Isa.

– The picture gets more complicated if your earnings fall between these two limits. If you earn less than the relevant personal allowance but your savings income takes you above it, then 20pc tax will automatically be deducted. You can apply to have half of this rebated by completing an R40 form.

So, for example, if a 70-year-old pensioner received an income of £10,000 a year from their pensions, but earned a further £1,000 a year from their savings, their total income of £11,000 would exceed their personal allowance (£10,500), so 20pc tax would be deduced from their savings interest, a loss of £200.

However, of the £1,000 earned, half should be tax-free, as it is still within their personal allowance, and the other half should be taxed at only 10pc. This means that if the saver completes an R40 form, they should be able to reclaim £150 of the £200 paid.